Are Profits more important than your Cash Flow?
That is actually a very easy question to answer – it is your businesses oxygen. Without cash the business will suffocate and die.
It is easy to fall into the trap of thinking that because you are making a good profit then all will be well. There are too many businesses that fail because of a lack of cash rather than a lack of profits.
Let us assume a business is making a good profit but has all its cash tied up in stock and debtors. When the time comes to pay creditors and there is no cash the creditors may refuse to supply, sales will be lost and the company will be on a downward spiral.
It is also important to make sure you have a good cash management system in place even in good times. If times get tough it is difficult to suddenly start putting pressure on customers when you have not done so before. Suppliers will expect payments to be on time, as before and your staff will certainly expect to be paid on time.
Below are some tips for managing your cash flow.
One of the first areas we all look to is our debtors (customers) and rightly so. Collecting cash on time is important, not only because it is better in our bank account than theirs but also the longer a debt is overdue the greater the chance of not collecting it becomes. Nothing can ruin a business faster than bad debts.
It is important to remember that the contract with your customers is a two way street, you undertake to supply a product or service and they undertake to pay for it. Never feel guilty or embarrassed to ask for the money due to you. A customer who is reluctant to pay may not be worth having as a customer and it may be better to concentrate on those who do pay.
The other ways of improving your cash flow from debtors are to either offer a discount for early payment or use debtor finance i.e. to sell your debtors to a finance house. These are more expensive but when cash flow is tight, they are good options to consider.
Just as you want your debtors to pay on time so too I believe it is good practice to pay your creditors on time. Treat your creditors well and they will look after you when you need them.
However, there is nothing wrong with asking for extended terms. This can be a great help in the short term.
Keep stock to a minimum and be very careful when buying stock. This is where it is important to have a good relationship with your suppliers. Rather buy in smaller lots with more frequent deliveries, but be aware of the higher price your supplier may charge for smaller quantities. If you are in a very tight cash position paying a little more is preferable to running out of cash but negotiate hard to keep the prices the same.
The other advantage of buying in smaller lots is that the risk of obsolete stock decreases significantly. Obsolete stock is almost as bad as a Bad Debt.
Sell off slow and obsolete stock as soon as you can. There is always a reluctance to sell off stock below cost as this means you are selling at a loss. Remember however that the longer you hold onto it, the less chance you have of selling it and the greater chance of it being damaged and then having to be disposed of.
Now is a good time to interrogate all your costs and be brutal in getting rid of non productive costs. Over time there can be numerous costs that creep into your business that go unnoticed or become “essential”. Have a look at all your costs and activities and ask the question – “Is this adding value to the business or just sucking up cash?”
I recently read an article about EasyJet in the UK which has become one of the biggest passenger services in the UK and their policy has always been, and remains, to run very, very tight cost control. Every little cost from stationery to tea is closely monitored. The little costs can add up to a big figure.
In costs I include staff costs and also your own drawings from the business.
When cash flow is tight and the business is at risk it is necessary to look very carefully and hard at the above areas. Sometimes tough decisions will have to be made and this can be painful. However without profits the cash flow will not correct itself in the medium to long term. So unless you have major investors who are convinced that the business will make money in the long term (think of Google or Facebook) then you have to make sure the business is profitable.
When thinking about all the areas above and taking steps to improve your cash flow be careful that you don’t take steps that will harm your longer term profitability.